Martin Witman on Fairness in Takeovers

What is hot in Wall Street this year? Private equity takeovers! Should
you be happy with a buyout if you are paid a 20% premium for the companies you
own? Maybe not. Legendary investor Marty Whitman shares his insight about Fairness in Takeovers.

What is Fairness in Takeovers?

Marty Whitman: FAIR PRICES IN TAKEOVERS
“Fair” is defined as that price, and other terms, that would be arrived at in a
transaction between willing buyers and willing sellers, both with knowledge of
the relevant facts and neither under any compulsion to act.

The problem is that in many transactions for companies whose common stocks
are publicly traded, especially Management Buy Outs (“MBOs”), the real world
situation is one of willing buyer-coerced seller; where the buyer is also an
agent who is supposed to represent the interests of the seller. The seller,
whose interest is supposed to be represented by the buyer, is the public
shareholder, or Outside Passive Minority Investor (“OPMI”). The buyer, at least
in part, is usually corporate management and/or control shareholders.

Coercion of Outside Passive Minority Investor

Marty Whitman: Coercion of OPMIs occurs in two ways:

1. In a merger, an OPMI is bound by the requisite vote (anywhere from 50% of
those voting to 2/3 of the outstanding shares) where the vote process is rigged
in favor of management and/or others who control the proxy machinery and whose
proxy solicitation is financed by the corporate treasury. It tends to be
utterly impractical for OPMIs to dissent from transactions and then perfect
their rights of appraisal, in the event that relevant State Statutes even give
OPMIs rights to seek an appraisal.

2. In tender offers (or occasionally other market purchases), OPMIs may face
the threat of the company going “dark” in that the non-tendering (or
non-selling) OPMI common stockholder will be left owning a security for which
there is no public market. Once “dark”, there may be no real market for the
common, and there could be a lack of many securities law protections for the
OPMI.

What makes a buyer a willing buyer and the seller a willing seller?

Marty Whitman: Therefore, the purpose of fairness opinions, and
fairness in general, ought to be to simulate a willing buyer–willing seller
environment even though there tends to be in the real world, a willing
buyer–coerced seller environment. Many appraisals by investment banks, and
others, do not recognize this and market price often will be the principal
determinant of the transaction price even where there is a willing
buyer–coerced seller situation. Put otherwise, in rendering many fairness
opinions, little or no consideration is given to the important question, “What
is the company worth to the buyer?”. For example, in Delaware, the leading
corporate state, there are no appraisal rights for OPMIs in 4 transactions
involving an exchange of common stocks where both issues of common stock are
publicly traded. Also in Delaware courts, fair value excludes consideration of
values arising out of the merger itself; in effect, do not consider or weigh
what the deal might be worth to the buyer. What makes an OPMI a willing seller?
A premium over market. What makes a control person a willing buyer? A price
that represents a discount from what the buyer thinks the business is really
worth to him, or his institution.

Wide disparity between what a willing seller will assume is a fair price
and what a willing buyer will assume is a fair price.

Marty Whitman: Thus, the Efficient Market Hypothesis notwithstanding,
there frequently is a huge gap between the price that would satisfy a willing
seller and the price that would satisfy a willing buyer. For example, TAVF owns
many securities selling at 30%- 50% discounts from readily ascertainable NAVs –
Toyota Industries, Wheelock, Hang Lung Group, Henderson Investment and St. Joe.
If these companies were to be acquired, I think TAVF ought to receive a very
substantial premium over market.

Given that OPMIs are willing sellers and control persons are willing buyers,
it is logical to assume that most of the time there will be a wide disparity
between what a willing seller will assume is a fair price and what a willing
buyer will assume is a fair price. Each group tends to focus on different
factors. The OPMI seller will tend to focus on those corporate variables most
likely to affect near-term market prices, to wit, short-term outlooks for
earnings, Earnings Before Interest, Taxes, Depreciation and Amortization
(“EBITDA”), dividends and industry identification. Control buyers, on the other
hand, tend to focus on how they can finance the transaction, the “Given that
OPMIs are willing sellers and control persons are willing buyers, it is logical
to assume that most of the time there will be a wide disparity between what a
willing seller will assume is a fair price and what a willing buyer will assume
is a fair price.” quality and quantity of resources in a business and longterm
outlooks.

A More Favorable Price for Outside Passive Minority Investor?

Marty Whitman: Obviously, takeover prices tend to be a lot more
favorable for OPMIs when the price arrived at is the result of competitive bids
rather than only negotiations between parties. A sale of assets under Section
363 in a Chapter 11 case is always a bidding contest where open bidding more or
less assures a fair price. The problem for most healthy companies is that most
corporate endeavors have to be negotiated – transactions are complex. Contracts
for negotiated transactions almost always contain “no shop”, “break up fee” and
“topping fee” clauses. These discourage the conversion of negotiated
transactions into bidding contests.

The argument is made by OPMI representatives, including the Plaintiff ’s Bar
and by Ben Stein, a New York Times columnist, that in an MBO-type transaction,
the control persons should be obligated to pay the OPMIs that price which
represents what the business is actually worth to the buyer.

What Will I Do in the Case of Buy-Out?

Marty Whitman:If control persons were
unable to buy businesses at prices that represent discounts for them, then
buying interest by control persons would dry up. TAVF runs a portfolio. Many of
the securities contained in the portfolio are issues of companies which are
takeover candidates. The last thing the Fund wants to do is to discourage major
buying interests, which offer premiums over market prices, from trying to
acquire the common stocks of TAVF portfolio companies. I think willing
buyer-willing seller is a much more useful standard than requiring a buyer to
pay full value.

As such, TAVF will give a wide berth and tend to vote in favor of most
merger transactions which offer the Fund a substantial premium over market.
However, where the price seems egregiously low compared to what we think the
business is worth to the buyer, the Fund will oppose (and certainly vote
against) such merger transactions, even where the prices offered reflect good
sized premiums over market.

Stocks Mentioned by Marty Whitman as Deep Discounted

Marty Whitman: Toyota Industries, Wheelock, Hang Lung Group,
Henderson Investment and St. Joe. If these companies were to be acquired, I
think TAVF ought to receive a very substantial premium over market.

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